During my two decades as a bank employee I only once came across a portfolio manager that applied the old adage of sell your losses and let your profits run. Do me a favor and look at the portfolio(s) you manage and tell me you don’t hold any losing positions. Don’t worry, you are not the only one that suffers from this so called disposition bias (you hold on to your losing stocks and sell the profitable ones). I got the remedy.

First off, let’s clear the table of all the excuses for not selling your already two week old losing equities:

“You can’t time the market so I DCA (dollar-cost-average) in.”

“Yes, the stock value is down to almost zero but that means it also has no other way to go than up.”

“Charlie Munger said in an interview that you have to be extremely patient and extremely decisive.”

“Ok, but only for tax loss harvesting.”

Does the four statements above sound familiar? Somewhat logical as well? There are some wise thoughts embedded in there but they are out of context.

There are two main reasons why the disposition bias is so lethal:

1. Alternative Cost. The money you have tied up in a losing position could be compounding.
2. The Perception of Percentual Gains and Losses. A loss of 20% requires a gain of 25% to recover and return to the original value.

Envision looking at your portfolio and it only contains holdings that have gone up in value. Picture your client looking at the portfolio you manage and not questioning why you have bought something that has gone down in value. The physical effort to achieve this satisfaction is a couple of clicks away. Yet, it so difficult for those that don’t apply one of the following strategies:

• State the exact time and frequency of the “garbage disposal” in the prospectus (yes, you can include this in it!)
• Commit to selling all losing positions by the end of every week/month/quarter.
• Have a supervisor enforce the sales.
• Only trade intra-day.
• Commit to having a set cash buffer and to only increase it through dividends and by selling losing positions.
• Utilize rules-based trading systems or algorithmic trading strategies, that remove emotional decision-making from the equation.
• Use stop-loss orders.

A very inexpensive way to have your portfolio management system nag on you, is to mirror your portfolio in Google Sheets or Microsoft Excel and set up pop-up and e-mail alerts for instance when you have a position under water more than 10%.

An easy and arguably the most common way out to fight the disposition bias, which I on purpose did not list, is to increase the holding as the price drops. If you have unlimited purchases, you will have unlimited losses with DAC. If you want to go all-in in one company, then apply for a job there or buy the whole company. At least you can then influence the outcome.

Personally, I hold each position in my long-term account at least six months. If it hasn’t performed, I sell it. For actively managed portfolios I prefer the end-of-week rule.

Let me know how you deal with disposition bias and if you have any good hacks you can recommend.